The Quality Closed-End Fund Report, March 2022: Attractive Valuations In Fixed Income Funds Emerge

Mar. 23, 2022 7:25 AM ETARDC, BFZ, BGB, BGH, BGX, CEV, DBL, DHF, DSL, EHI, EIM, ENX, EVM, FPF, HFRO, HFRO.PA, HYB, IHIT, IHTA, IVH, JPC, JPI, JPS, KIO, NMI, NUO, PGP, PHT, SRV, WEA18 Comments21 Likes

Summary

  • Only funds with coverage >100% are considered for this quality closed-end fund report.
  • Top lists of discount, yield, DxY and DxYxZ are given.
  • Top DxYxZ funds are KIO, ARDC and DSL.
  • I do much more than just articles at CEF/ETF Income Laboratory: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »

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Author's note: This article was released to CEF/ETF Income Laboratory members on March 16, 2022. Please check latest data before investing.

Quantitative screens help to rapidly narrow down attractive candidates from the database of 500-plus closed-end funds for further due diligence and investigation.

CEF income

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Based on feedback from members, it seems that a very many number of investors, understandably, place a great emphasis on coverage and return of capital. While I'm not going to rehash the entire ROC argument here (it is suffice to say that the issue is much more complicated than "ROC = bad"), some investors may consider a fund with over 100% coverage to be attractive simply because they know that the distributions are being covered by earnings. Such a fund may be at lower risk of a distribution cut, which can cause devastating impacts to a fund's market price and may even afford to raise its distribution in the future.

What does the "quality" label indicate? Simply put, it means that the distribution coverage is greater than 100%. However, please note these caveats: Firstly, coverage ratios are calculated using earnings data from CEFConnect. Although there are sometimes discrepancies with CEFConnect's data, this allows us to automate the calculation process for the entire universe, and we consider it to be sufficient for a preliminary screen anyway. Before buying or selling any fund, it's recommended to independently verify the coverage ratios from the individual fund annual/semi-annual reports themselves. Secondly, having a coverage ratio >100% does not guarantee that the fund's distribution is secure. Many funds reduce their distributions periodically in line with market conditions in order to maintain good coverage. Thirdly, a coverage cut off ratio of 100% is, ultimately, an arbitrary number. A fund with 99.9% coverage will be excluded from the rankings, whereas funds with 100.1% coverage will be considered, even though only a sliver of coverage separates the two.

The coverage ratio is calculated by dividing the earnings/share number provided by CEFConnect on the "distributions" tab by the distribution/share. CEFdata also provides earning coverage numbers as well.

I hope that these rankings of quality CEFs will provide fertile ground for further exploration.

Key to table headings:

P/D = premium/discount

Z = 1-year z-score

Lev = leverage

BE = baseline expense

Cov = coverage

Data were taken from the close of March 14th, 2022.

1. Top 10 widest quality discounts

The following data show the 10 CEFs with the highest discounts and coverage >100%. Yields, z-scores and leverage are shown for comparison.

CEF Category P/D Yield Z Lev BE Cov
(HFRO) Senior Loans -24.39% 8.07% -1.4 12% 1.67% 113%
(SRV) MLPs -19.13% 5.62% 0.1 28% 2.21% 122%
(BFZ) California Munis -13.25% 4.16% -2.4 41% 1.05% 104%
(ENX) New York Munis -13.17% 4.05% -2.3 36% 1.06% 106%
(ARDC) Senior Loans -13.09% 8.61% -2.9 25% 2.08% 117%
(HYB) High Yield -12.99% 7.66% -2.2 29% 1.13% 104%
(HYB) High Yield -12.99% 7.66% -2.2 29% 1.13% 104%
(CEV) California Munis -12.61% 4.87% -2.6 39% 1.10% 100%
(EVM) California Munis -12.54% 4.56% -2.6 42% 1.11% 107%
(DHF) High Yield -12.12% 8.52% -1.9 31% 1.27% 110%

CEFs - Top 10 widest quality discounts

Income Lab

2. Top 10 best quality z-scores

CEFs with the best (most negative) z-scores are potential buy candidates. The following data show the 10 CEFs with the lowest z-scores. Premium/discount, yields and leverage are shown for comparison. Only funds with coverage >100% are considered.

CEF Category Z P/D Yield Lev BE Cov
(KIO) High Yield -3.7 -11.39% 9.21% 37% 2.12% 109%
(EIM) National Munis -3.3 -10.30% 4.75% 42% 1.09% 105%
(PGP) Global Allocation -3.3 -4.37% 9.96% 38% 1.66% 104%
(JPS) Preferreds -3.2 -9.53% 7.70% 39% 1.29% 102%
(IHTA) High Yield -3.0 -4.18% 5.45% 25% 1.26% 118%
(ARDC) Senior Loans -2.9 -13.09% 8.61% 25% 2.08% 117%
(DSL) Global Income -2.9 -11.01% 9.67% 33% 1.50% 123%
(NUO) Single-state Munis -2.8 -12.99% 4.20% 36% 1.02% 104%
(NMI) National Munis -2.7 -6.00% 3.24% 3% 0.73% 106%
(DBL) Multisector Income -2.7 -6.06% 7.89% 18% 1.43% 101%

CEFs - Top 10 best quality z-scores

Income Lab

3. Top 20 highest quality yields

Some readers are mostly interested in obtaining income from their CEFs, so the following data presents the top 20 highest yielding CEFs. I've also included the premium/discount and z-score data for reference. Before going out and buying all 10 funds from the list, some words of caution: [i] higher yields generally indicate higher risk, and [ii] some of these funds trade at a premium, meaning you will be buying them at a price higher than the intrinsic value of the assets (which is why I've included the premium/discount and z-score data for consideration). Only funds with coverage >100% are considered. To make the charts more manageable, I've split the funds into two groups of 10.

CEF Category Yield P/D Z Lev BE Cov
(PGP) Global Allocation 9.96% -4.37% -3.3 38% 1.66% 104%
(EHI) High Yield 9.95% -9.00% -2.5 35% 1.37% 103%
(DSL) Global Income 9.67% -11.01% -2.9 33% 1.50% 123%
(PHT) High Yield 9.61% -11.05% -2.2 33% 1.06% 107%
(KIO) High Yield 9.21% -11.39% -3.7 37% 2.12% 109%
(ARDC) Senior Loans 8.61% -13.09% -2.9 25% 2.08% 117%
(DHF) High Yield 8.52% -12.12% -1.9 31% 1.27% 110%
(BGH) High Yield 8.50% -12.07% -2.6 28% 1.47% 122%
(HFRO) Senior Loans 8.07% -24.39% -1.4 12% 1.67% 113%
(DBL) Multisector Income 7.89% -6.06% -2.7 18% 1.43% 101%
(JPC) Preferreds 7.88% -8.91% -2.5 39% 1.32% 105%
(JPS) Preferreds 7.70% -9.53% -3.2 39% 1.29% 102%
(HYB) High Yield 7.66% -12.99% -2.2 29% 1.13% 104%
(FPF) Preferreds 7.55% -7.85% -2.4 34% 1.33% 102%
(JPI) Preferreds 7.38% -5.22% -2.3 37% 1.33% 105%
(IVH) High Yield 7.29% -11.47% -2.3 3% 1.51% 108%
(WEA) Investment Grade 6.74% -7.54% -2.4 32% 0.94% 110%
(BGX) Senior Loans 6.68% -9.88% -2.0 39% 2.06% 122%
(BGB) Senior Loans 6.18% -8.60% -1.4 37% 2.17% 112%
(IHIT) High Yield 6.08% -3.44% -2.0 27% 1.08% 125%

CEFs - Top 10 highest quality yields

Income Lab

4. Top 10 best combination of quality yield and discount

For possible buy candidates, it's probably a good idea to consider both yield and discount. Buying a CEF with both a high yield and discount not only gives you the opportunity to capitalize from discount contraction, but you also get "free" alpha every time the distribution is paid out. This is because paying out a distribution is effectively the same as liquidating the fund at NAV and returning the capital to the unitholders. I considered several ways to rank CEFs by a composite metric of both yield and discount. The simplest would be yield + discount. However, I disregarded this because yields and discounts may have different ranges of absolute values and a sum would be biased toward the larger set of values. I finally settled on the multiplicative product, yield x discount. This is because I consider a CEF with 7% yield and 7% discount to be more desirable than a fund with 2% yield and 12% discount, or 12% yield and 2% discount, even though each pair of quantities sum to 14%. Multiplying yield and discount together biases toward funds with both high yield and discount. Since discount is negative and yield is positive, the more negative the "DxY" metric, the better. Only funds with >100% coverage are considered. The DxY score is scaled by 100.

CEF Category P/D Yield Z DxY Lev BE Cov
(HFRO) Senior Loans -24.39% 8.07% -1.4 -2.0 12% 1.67% 113%
(ARDC) Senior Loans -13.09% 8.61% -2.9 -1.1 25% 2.08% 117%
(SRV) MLPs -19.13% 5.62% 0.1 -1.1 28% 2.21% 122%
(DSL) Global Income -11.01% 9.67% -2.9 -1.1 33% 1.50% 123%
(PHT) High Yield -11.05% 9.61% -2.2 -1.1 33% 1.06% 107%
(KIO) High Yield -11.39% 9.21% -3.7 -1.0 37% 2.12% 109%
(DHF) High Yield -12.12% 8.52% -1.9 -1.0 31% 1.27% 110%
(BGH) High Yield -12.07% 8.50% -2.6 -1.0 28% 1.47% 122%
(HYB) High Yield -12.99% 7.66% -2.2 -1.0 29% 1.13% 104%
(EHI) High Yield -9.00% 9.95% -2.5 -0.9 35% 1.37% 103%

CEFs - Top 10 Quality CEFs

Income Lab

5. Top 10 best combination of quality yield, discount and z-score

This is my favorite metric because it takes into account all three factors that I always consider when buying or selling CEFs: Yield, discount and z-score. The composite metric simply multiplies the three quantities together. A screen is applied to only include CEFs with a negative one-year z-score. As both discount and z-score are negative while yield is positive, the more positive the "DxYxZ" metric, the better. Only funds with >100% coverage are considered. The DxYxZ score is scaled by 100.

CEF Category P/D Yield Z DxYxZ Lev BE Cov
(KIO) High Yield -11.39% 9.21% -3.7 3.9 37% 2.12% 109%
(ARDC) Senior Loans -13.09% 8.61% -2.9 3.3 25% 2.08% 117%
(DSL) Global Income -11.01% 9.67% -2.9 3.1 33% 1.50% 123%
(HFRO) Senior Loans -24.39% 8.07% -1.4 2.8 12% 1.67% 113%
(BGH) High Yield -12.07% 8.50% -2.6 2.7 28% 1.47% 122%
(PHT) High Yield -11.05% 9.61% -2.2 2.4 33% 1.06% 107%
(JPS) Preferreds -9.53% 7.70% -3.2 2.3 39% 1.29% 102%
(EHI) High Yield -9.00% 9.95% -2.5 2.3 35% 1.37% 103%
(HYB) High Yield -12.99% 7.66% -2.2 2.2 29% 1.13% 104%
(DHF) High Yield -12.12% 8.52% -1.9 2.0 31% 1.27% 110%

CEFs - Top 10 best combination of quality yield, discount and z-score

Income Lab

Commentary

The top DxYxZ funds from this month's Quality report are:

  • KKR Income Opportunities Fund (KIO): -11.39% discount, 9.21% yield, -3.7 z-score
  • Ares Dynamic Credit Allocation Fund (ARDC): -13.09% discount, 8.61% yield, -2.9 z-score
  • DoubleLine Income Solutions Fund (DSL): -11.01% discount, 9.67% yield, -2.9 z-score

These three funds, led by well-known alternative asset managers KKR, Ares and DoubleLine, have all sold off this year as the risk-off mentality took hold.

KIO vs ARDC vs DSL premium to NAV

YCharts

As a result, yields of these funds have spiked higher to levels not seen since a year ago.

KIO vs ARDC vs DSL discount yield

YCharts

KIO and ARDC are "dynamic" credit funds that can allocate across high-yield bonds and senior loans. ARDC also has a significant allocation to CLO debt and equity as well which KIO does not have.

DSL is also a diversified fixed income fund, but has a substantial exposure to emerging market bonds which KIO and ARDC do not have.

The emerging market exposure is probably why DSL, although having kept pace with KIO and ARDC for most of the last 5 years, has diverged (underperformed) over the past couple of months as geopolitical tensions flared.

KIO vs ARDC vs DSL total return NAV

YCharts

I view all of KIO, ARDC and DSL as attractively-valued candidates to add to for the fixed income investor. However, those who do not desire emerging market exposure should eschew DSL.

ARDC is a holding of our Tactical Income-100 portfolio, and we last added to it on February 25, 2022.

Nick has recently covered DSL for our members here: DSL: Fully Covered 7.72% Distribution Yield

In the members section, we provide specific commentary on the top ranked funds and discuss whether they deserve a place in your income portfolio. At the CEF/ETF Income Laboratory, we manage market-beating closed-end fund (CEF) and exchange-traded fund (ETF) portfolios targeting safe and reliable ~8% yields to make income investing easy for you. Check out what our members have to say about our service.

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Disclosure: I/we have a beneficial long position in the shares of ARDC either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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